Fortunately, there’s another path that doesn’t take big bucks: time. A little bit of money per year goes a long way when you’re able to invest in a diversified portfolio for decades.
Just how powerful is compound interest? Money expert Clark Howard recently fielded a question about that on a December podcast.
“If you have a child who is 25 years old and you give them $500 for Christmas every year for 20 years and ask them to put it in their Roth IRA, how much will it be worth when they retire at 65 years old, given an average rate of return?” a listener asked Clark.
Depending on the variables you input, you'll get a slightly different answer. I used the investment calculator at calculator.net, deciding to contribute all $500 at the end of each year. Clark assumed a 7% annual return on investment (ROI) in his podcast answer, so I went with that number as well.
Here are the results after 20 years:
| Starting Balance | Yearly Contributions | Years Contributed | Annual ROI | Final Balance |
|---|---|---|---|---|
| $0 | $500 | 20 | 7% | $20,497.75 |
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Of course, the listener’s child would have 20 more years prior to retirement. Even if the son or daughter didn’t add a single cent to the IRA, here’s how much that money would grow into by the time he or she retired:
| Starting Balance | Yearly Contributions | Years Contributed | Annual ROI | Final Balance |
|---|---|---|---|---|
| $20,497.75 | $0 | 20 | 7% | $79,319.82 |
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Let’s say that once the parent stopped contributing, the child — now 45 years old — contributed $500 a year of their own, also at the end of each year, until they turned 65.
| Starting Balance | Yearly Contributions | Years Contributed | Annual ROI | Final Balance |
|---|---|---|---|---|
| $20,497.75 | $500 | 20 | 7% | $99,817.57 |
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To recap, simply by putting $500 into a Roth IRA every year from 25 years old to 65 years old, you can build up close to $100,000 in retirement savings even if the money earns only modest returns.
One of the more interesting observations: The $500 per year that the parent would contribute in the first 20 years would result in about four times as much money as the same $500 per year contributed for the last 20 years.
Parent's contributions at retirement: $79,319.82
Child's contributions at retirement: $20,497.75
“Time in the market matters the most. So the money put in earlier has a bigger impact than money put in later,” Clark says. “The big benefit was putting money in over [decades]. Time is your ally with investing and creating financial security.”
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